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Accounting notes

In business activity a lot of “give & take” exist which is known as transaction. Transaction
involves transfer of money or money’s worth. Thus exchange of money, goods & services
between the parties is known to have resulted in a transaction.
It is necessary to record all these transactions very systematically & scientifically so that the
financial relationship of a business with other persons may be properly understood, profit & loss
and financial position of the business may be worked out at a particular date. The procedure to
record all these transactions is known as “Book-keeping”.
In other words the book keeping may be defined as an activity concerned with the recording of
financial data relating to business operations in an orderly manner. Book keeping is the recording
phase of accounting.

Accounting is based on an efficient system of book keeping. Accounting is the analysis &
interpretation of book keeping records. It includes not only the maintenance of accounting
records but also the preparation of financial & economic information which involves the
measurement of transactions & other events relating to entry.

Terminology -

1) Assets: An asset may be defined as anything of use in the future operations of the enterprise &
belonging to the enterprise. E.g., land, building, machinery, cash etc.
(a) Non Current Assets : Fixed assets : Tangible & Intangible ( more than 1 year period)

 Tangible Assets: Land and Building Plant and Machinery Furniture Office Equipments
 Intangible Assets: Goodwill Patents Trademarks Copyright Computer software

(b) Current assets (less than 1 year period) Examples Debtors , Bills Receivable, Cash in hand ,
Cash at bank , Cheques in hand , Drafts in hand , Stock , Prepaid Expenses

 2) Equity: In broader sense, the term equity refers to total claims against the enterprise. It
is further divided into two categories.
i. Owner Claim - Capital
ii. Outsider’s Claim – Liability
Capital: The excess of assets over liabilities of the enterprise. It is the difference between
the total assets & the total liabilities of the enterprise. e.g.,: if on a particular date the
assets of the business amount to Rs. 1.00 lakhs & liabilities to Rs. 30,000 then the capital
on that date would be Rs.70,000/-.
Liability: Amount owed by the enterprise to the outsiders i.e. to all others except the
owner. e.g.,: trade creditor, bank overdraft, loan etc.
-Non Current Liabilities: Bank Loan Mortgage Loan from other financial institutions
Other long term liabilities
-Current Liabilities: Creditors Bills Payable Outstanding Expenses Bank overdraft

3) Revenue: It is a monetary value of the products or services sold to the customers during the
period. It results from sales, services & sources like interest, dividend & commission.

4) Expense/Cost: Expenditure incurred by the enterprise to earn revenue is termed as expense or


cost. The difference between expense & asset is that the benefit of the former is consumed by the
business in the present whereas in the latter case benefit will be available for future activities of
the business. e.g., Raw material, consumables & salaries etc.

5) Drawings: Money or value of goods belonging to business used by the proprietor for his
personal use.

6) Owner: The person who invests his money or money’s worth & bears the risk of the
business.

7) Sundry Debtors: A person from whom amounts are due for goods sold or services rendered
or in respect of a contractual obligation. It is also known as debtor, trade debtor, accounts
receivable.

8) Sundry Creditors: It is an amount owed by the enterprise on account of goods purchased or


services rendered or in respect of contractual obligations. e.g., trade creditor, accounts payable

OBJECTIVES

 To maintain the books of accounts


 To prepare the annual accounts

ACCOUNTING CYCLE

After taking decisions such as selecting a business, selecting the form of organization of
business, making decision about the amount of capital to be invested, selecting suitable site,
acquiring equipment & supplies, selecting staff, getting customers & selling the goods etc. a
business man finally resorts to record keeping. For all types of business organizations,
transactions such as purchases, sales, manufacturing & selling expenses, collection from
customers & payments to suppliers do take place. These business transactions are recorded in a
set of ruled books such as journal, ledger, cash book etc. Unless these transactions are recorded
properly he will not be in a position to know where exactly he stands. The following is the
complete cycle of Accounting
a) The opening balances of accounts from the balance sheet & day to day business transaction of
the accounting year are first recorded in a book known as journal.
b) Periodically these transactions are transferred to concerned accounts known as ledger
accounts.
c) At the end of every accounting year these accounts are balanced & the trial balance is
prepared.
d) Then the final accounts such as trading & profit & loss accounts are prepared.
e) Finally, a balance sheet is made which gives the financial position of the business at the end of
the period.

ACCOUNTING ASSUMPTIONS

1. Going Concern: In the ordinary course accounting assumes that the business will continue to
exist & carry on its operations for an indefinite period in the future. The entity is assumed to
remain in operation sufficiently long to carry out its objects and plans. The values attached to the
assets will be on the basis of its current worth. The assumption is that the fixed assets are not
intended for re-sale. Therefore, it may be contended that a balance sheet which is prepared on the
basis of record of facts on historical costs cannot show the true or real worth of the concern at a
particular date. The underlying principle there is that the earning power and not the cost is the
basis for valuing a continuing business. The business is to continue indefinitely and the financial
and accounting policies are followed to maintain the continuity of the business unit.

2. Consistency: There should be uniformity in accounting processes and policies from one
period to another. Material changes, if any, should be disclosed even though there is
improvement in technique. Only when the accounting procedures are adhered to consistently
from year to year the results disclosed in the financial statements will be uniform and
comparable.

3. Accrual: Accounting attempts to recognize non-cash events and circumstances as they occur.
Accrual is concerned with expected future cash receipts and payments. It is the accounting
process of recognizing assets, liabilities or income amounts expected to be received or paid in
future. Common examples of accruals include purchases and sales of goods or services on credit,
interest, rent (unpaid), wages and salaries, taxes. Thus, we make record of all expenses and
incomes relating to the accounting period whether actual cash has been disbursed or received or
not. In order to keep a complete record of the entire transactions of any business it is necessary to
keep the following accounts:
a) Assets Accounts: These accounts relate to tangible and intangible assets. e.g., Land a/c,
building a/c, cash a/c, goodwill, patents etc.
b) Liabilities Accounts: These accounts relate to the financial obligations of an enterprise
towards outsiders. e.g., trade creditors, outstanding expenses, bank overdraft, long-term loans.
c) Capital Accounts: These accounts relate to the owners of an enterprise. e.g., Capital a/c,
drawing a/c.
d) Revenue Accounts: These accounts relate to the amount charged for goods sold or services
rendered or permitting others to use enterprise’s resources yielding interest, royalty or dividend.
e.g., Sales a/c, discount received a/c, dividend received a/c, interest received a/c.
e) Expenses Account: These accounts relate to the amount spent or lost in the process of earning
revenue. e.g., Purchases a/c, discount allowed a/c, royalty paid a/c, interest payable a/c, loss by
fire a/c.

SYSTEMS OF RECORDING
There are two methods of recording of entries which are explained as under:

Single Entry System: This system ignores the two fold aspect of each transaction as considered
in double entry system. Under single entry system, merely personal aspects of transaction i.e.
personal accounts are recorded. This method takes no note of the impersonal aspects of the
transactions other than cash. It offers no check on the accuracy of the posting and no safeguard
against fraud and because it does not provide any check over the recording of cash transactions ,
it is called as “imperfect accounting”.

Double entry system: The double entry system was first evolved by Luca Pacioli, who was a
Franciscan Monk of Italy. With the passage of time, the system has gone through lot of
developmental stages. It is the only method fulfilling all the objectives of systematic accounting.
It recognizes the two fold aspect of every business transaction.

BASIS OF ACCOUNTING SYSTEM

Cash or receipt basis is the method of recording transactions under which revenues and costs
and assets and liabilities are reflected in accounts in the period in which actual receipts or actual
payments are made. “Receipts and payments account” in case of clubs, societies, hospitals etc., is
the example of cash basis of accounting.

Accrual or mercantile basis is the method of recording transactions by which revenues, costs,
assets and liabilities are reflected in accounts in the period in which they accrue. This basis
includes considerations relating to outstanding; prepaid, accrued due and received in advance.
Hybrid or mixed basis is the combination of both the basis i.e. cash as well as mercantile basis.
Income is recorded on cash basis but expenses are recorded on mercantile basis.

CLASSIFICATION OF ACCOUNTS
The classification of accounts and rules of debit and credit based on such classification are given
below:

Personal Accounts: Accounts recording transactions relating to individuals or firms or company


are known as personal accounts.
Personal accounts may further be classified as:
(i) Natural Person’s personal accounts: The accounts recording transactions relating to individual
human beings e.g., Anand’s a/c, Ramesh’s a/c, Pankaj a/c are classified as natural persons’
personal accounts.
(ii) Artificial Persons’ Personal accounts: The accounts recording transactions relating to limited
companies, bank, firm, institution, club, etc., Delhi Cloth Mill; M/s Sahoo & Sahoo; Hans Raj
College; Gymkhana Club are classified as artificial persons’ personal accounts.
(iii) Representative Personal Accounts: The accounts recording transactions relating to the
expenses and incomes are classified as nominal accounts. But in certain cases (due to the
matching concept of accounting) the amount, on a particular date, is payable to the individuals or
recoverable from individuals. Such amount
(i) relates to the particular head of expenditure or income and
(ii) represent persons to whom it is payable or from whom it is recoverable. Such accounts are
classified as representative personal accounts e.g., “wages outstanding account”, pre-paid
Insurance account, etc.

Real Accounts: The accounts recording transactions relating to tangible things (which can be
touched, purchased and sold) such as goods, cash, building, machinery etc., are classified as
tangible real accounts. Whereas the accounts recording transactions relating to intangible things
(which do not have physical shape) such as goodwill, patents and copy rights, trade marks etc.,
are classified as intangible real accounts.

Nominal Accounts: The accounts recording transactions relating to the losses, gains, expenses
and incomes e.g. Rent, salaries, wages, commission, interest, bad debts etc., are classified as
nominal accounts.

Rules of debit and credit (classification based)

1. Personal accounts : Debit the receiver Credit the giver (supplier)

2. Real accounts : Debit what comes in Credit what goes out

3. Nominal accounts : Debit expenses and losses Credit incomes and gains